A Nobel Economics winner, Vernon Smith, has cautioned that Australia’s property bubble is unsustainable. Professor Smith won the award in 2002 for his studies into experimental economics. As an authority on the subject of bubbles, his conclusions will come as a warning to every investor and homeowner.

Professor Smith’s assessment of the market joins the growing chorus of experts proclaiming a property bubble. Here’s what he had to say:

‘You have a pretty good bubble in Sydney and Melbourne. It is hard to believe it is very sustainable’.

That probably doesn’t come as any revelation to you. You’ll have heard all this before by now. What takeaway can we make from this, then?

As far as I see it, two things stand out that should interest most Aussie investors.

The first is the question of sustainability. That’s a vague word in the context of the property market. Sustainability doesn’t give us any time frame for when things become, you know, unsustainable.

Professor Smith is probably correct about Sydney and, to a lesser extent, Melbourne. It’s more than likely that both are in emerging property bubbles. Certainly, it’s hard to dispute the theory that Sydney is in the middle of one. There’s enough evidence, in relation to rising prices, to suggest as much. However, what’s less clear is where this bubble sits in the current property cycle.

That leads me directly to the second point.

How much longer before the property bubble pops?

If we concede that Sydney is in the midst of a growing bubble, something will have to give eventually. In that respect, current property prices probably aren’t sustainable in the long run. But you knew that already.

Everything works in cycles. Things rise, then they fall; then they rise again. The latest property cycle has risen in line with the historic economic growth of the last 15 years. And, as this golden period winds down, property prices will readjust too.

But you’re probably most interested in knowing where we are on this ‘path of unsustainability’. That, as you can imagine, is never easy to predict; otherwise we’d all be property moguls.

One person who might have the answer is The Daily Reckoning’s property expert, Phil Anderson. I won’t elaborate on it here, but you owe it to yourself to check out his model on Australia’s long term property market, by clicking here. If you’d like to know more about cycles in real estate you can do that right here.

But we can say, with a degree of confidence, that Australia’s property bubble still has legs. Again, when we talk about an Australian property bubble, we’re really just referring to Sydney.

Median house prices in Sydney are now projected at anywhere between $900,000 to $1 million, depending on who you ask. In any case, median prices are among the highest in the world; higher than London’s even. Only New York and Paris pip Sydney in this respect.

The question then really becomes one regarding Sydney’s longevity. How long will property prices either grow, or remain stable?

One way we can judge this is by looking at the US property crash for any clues to help guide us. That’s exactly what Professor Smith did.

Even though Professor Smith calls Sydney’s bubble unsustainable, his evidence suggests that Sydney could run hot for some time yet.

The US housing crash as an example for Sydney

Unlike the nationwide US housing crash, Sydney is the only city currently with serious question marks over it. That’s not to downplay Melbourne’s situation, but its problems are on a smaller scale in comparison.

If we compare Australia’s housing market to the US, there’s a huge difference. Would the US bubble have been so bad if it was contained to New York? Not even close.

But as the nation’s largest city, Sydney isn’t completely divorced from the rest of the country. Sydney is Australia’s biggest economy, employing the most number of people. Any housing crash would have ramifications for the rest of the country.

If the net worth of the average Sydneysider declined, it’d have a knock-on effect on the unemployment rate. In turn that’d put even more pressure on economic growth.

The point here is that Sydney’s housing bubble is unique. It wouldn’t affect house prices across other cities in the way that we saw in the US. Some markets, like Perth, are declining even in the midst of national property growth rates of 7%.

What this means is that it’ll be hard to pinpoint the exact moment property prices start falling. That’s because there are too many national and local factors at odds with each other.

But it does suggest that Sydney has some way to go. Why?

Well, for one, Aussie regulators have firmer control over the market than their US counterparts did. The Financial Review outlined some of these key differences:

‘Many of the loans remain on bank’s balance sheets, reducing the [speed] of lending. Overall gearing is surprisingly low with mortgages on only 5.3 million of the nation’s 9.5 million homes. And the banks, at the behest of the regulators, are moving to reduce the growth in investor lending’.

Of equal importance is that rents continue to rise in both Sydney and Melbourne. Median rents for Sydney apartments increased by 2% in the June quarter. House rents also rose by 2% during the same period, to $510 a week.

Rents in the US, by contrast, weren’t rising in the lead up to the housing crash.

This tells us that Sydney’s bubble is nowhere near popping. Not only is demand high, but there’s a shortage of supply to boot. That should calm fears that the bubble will pop anytime soon. For the foreseeable future, it looks as if Sydney’s market is only heading in a positive direction.

Preventing a bursting bubble

There’s a lot authorities can do to soften the impact of any future price correction. In Professor Smith’s view, one way to alleviate the dangers of a housing crash is to promote more flexible mortgages. He explains:

‘[The US crash] was a balance sheet recession with property values falling against fixed long term debt’.

In other words, US house prices fell, but mortgage debts on those properties were unchanged. Essentially that means that household balance sheets were significantly worse off in the aftermath.

By his count, the market collapse wiped out a total $7.5 trillion of equity between 2006 and 2009. Equity here refers to the value of homes minus the outstanding debt. That means that, by 2009, housing equity had fallen by 58%.

So what’s the alternative? Issuing more flexible mortgages that would leave household balance sheets intact in the event of a downturn.

Just don’t bet against this property bubble remaining sustainable for some time yet.

Mat Spasic,

Contributor, The Daily Reckoning

PS: The Aussie property market is still growing. It may be a two-speed market, but the majority of capital cities are still growing. The Daily Reckoning’s property expert, Phillip J. Anderson, is bullish on the market’s future.

Phil says that the national housing market is only set to continue growing. He says that Aussie real estate will boom for the next decade.

Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He correctly predicted the 2008 housing market crash. He also went against the trend in 2009, saying that house prices would go on to boom this decade.

He was right on both accounts.

In his latest free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.

for the better part of a year, now, slewie has been warning people about betting against the US Dollar. ——————————————————————————- slewie’s ‘FLATION Report ~for US Wednesday ~US Dollars only US Dollar INDEX 97.1 +0.4 BLOOMBERG COMMODITY INDEX 93.0; +0.2; [+0.22%] net DEflation, today, no Correlation. apparently the FED rate decision, today, was: yu-Nanny-mouse! Grrrr! i am an optimist, though, and i do think that if it weren’t for the FED, the CFR, the DOD, the Congress, the President’s Administration, the Supreme Court, lawyers, both major political parties, the Joint Chiefs, and the Chamber Of Commerce, things might turn up, nicely,… Read more »

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